Hedge funds are betting that trade wars, a shrinking economy, and rising strain among borrowers will hit private credit in the U.S., according to a Bloomberg report. The gamble appears to be paying off, with short sellers making approximately $1.7 billion on paper this year from wagers against seven of the biggest direct lenders, including Apollo Global Management Inc., Ares Management Corp., and Blue Owl Capital Inc.
While direct lenders have positioned tariff-induced volatility as an opportunity to capture more market share, their stock prices have fallen in recent months due to policy and economic uncertainty. The International Monetary Fund added to these concerns last month, warning that borrowers’ deteriorating credit quality hasn’t been reflected in the industry’s loan valuations.
“Alternative asset managers are very exposed if we do have a recession. If company revenue falls, cash flow falls which means leverage goes up and free cash flow goes out the window,” said Scott Roberts, senior managing partner at Belvedere Direct Lending Advisors.
Market participants also worry about fierce competition between private credit funds driving down returns and exposure to weaker borrowers who are most vulnerable to recession. The report highlights concerns about loan valuations, with Adams Street executives citing “substantial evidence” that direct lenders may be concealing problem loans and overstating portfolio yields and returns.
Particular attention is focused on payment-in-kind (PIK) loans, where borrowers can defer cash interest payments. More than 25% of net investment income at some business development companies was composed of PIK by late 2024. Ernst & Young noted that approximately 75% of PIK loans were valued at over 95 cents on the dollar, raising questions about valuation consistency compared to similar public market loans.
